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03 September 2013
In Ross River v Waveley Commercial Limited the Court of Appeal considered the circumstances in which individuals who control companies owe fiduciary duties to third parties that deal with their companies in the context of a joint venture agreement, and whether causing a company to incur legal costs to defend a claim may itself amount to a breach of duty.
The litigation arose from a joint venture project concerning the development of land in Ampthill, Bedfordshire. The project was initiated by Mr Barnett, the second defendant and respondent to the appeal, together with Mr Harney, the third defendant, who took no active part in the litigation.
In 2004 the first defendant, Waveley Commercial Ltd (WCL), owned by Barnett and Harney, was incorporated and a joint venture agreement was entered into between the claimant, Ross River, and WCL. Pursuant to the terms of the joint venture agreement, Ross River financed the purchase of a plot of land that was necessary to enable the project to proceed. Barnett and Harney were parties to the joint venture agreement, but only as guarantors of certain liabilities of WCL, which were immaterial to the dispute.
Under the terms of the joint venture agreement, Ross River was entitled to a share of the net profits of the project (as defined in the agreement). In August 2005 the parties entered into a side agreement that increased Ross River's entitlement from one-third of net profits to £560,000 plus one-third, and gave priority to Ross River's entitlement to that amount. Later, another agreement increased Ross River's share from one-third to 40%.
The development was completed in 2007, but its realisation took a long time and the last elements of the scheme were not sold until 2011. By 2008 Ross River had become dissatisfied with the lack of progress and lack of information supplied by WCL, and became suspicious of some of WCL's dealings. Litigation was commenced in 2009 with an application by Ross River for an injunction to restrain what was said to be an improper sale of part of the development by WCL.
By the time of the trial in 2011, the dispute had mushroomed and the central issues in contention concerned the amount of the net profits to which Ross River was entitled and whether Barnett was personally liable to Ross River for breach of fiduciary duty. Ross River argued that Barnett personally owed it fiduciary duties that he had breached by causing WCL to make payments and incur liabilities to third parties (sometimes connected to him) which had nothing to do with the project.
By 2011 WCL was unable to pay its debts as they fell due and a judgment against WCL was unlikely to be of any real value to Ross River. It was therefore important for Ross River to establish a direct remedy against Barnett.
As part of its case, Ross River contended that, in substance, all of the legal costs incurred by WCL in defending the litigation were for Barnett's benefit and WCL had no good reason to incur legal costs in defending the claim at all. This was based on the proposition that, when the claim was commenced, WCL's liabilities to Ross River far exceeded its assets. WCL was therefore insolvent on any basis and it could not improve its position by resisting the proceedings. Ross River argued that the only person whose position was at risk in the proceedings (ignoring Harney) was Barnett. Therefore, it was for his sake, and not at all for WCL's sake, that the defence was mounted and maintained, and he should have been solely liable for the defence costs. Since the costs incurred in defending the proceedings could not be regarded as joint venture expenditure, it was said that Barnett's conduct in making WCL liable for the defence costs was itself a breach of fiduciary duty.
The judge at first instance decided most of the issues in favour of Ross River, including that it was due £1,043,926 in net profits and that WCL and Barnett owed it fiduciary duties of good faith and not to do anything as regards the handling of the joint venture revenues that favoured WCL (and Barnett) to the disadvantage of Ross River. However, the judge rejected Ross River's argument that they owed a more extensive fiduciary duty to account for any payments out of joint venture parties to third parties; he considered that provided that WCL could reasonably have expected its share of net profits to exceed any given payment at the time it was made, WCL and Barnett had fulfilled their duties. The judge also decided that WCL was entitled to defend itself in the litigation and to incur costs accordingly. The consequence of the judge's findings was that Barnett was not liable to Ross River for any equitable compensation.
Ross River was given permission to appeal the judge's decision on the extent of the fiduciary duties owed by WCL and Barnett.
Barnett and WCL contended on appeal that the judge had been wrong to find that either of them owed any fiduciary duty to Ross River. They argued that the joint venture was set up and conducted on a purely contractual basis, with the rights and obligations of the parties set out in the joint venture agreement, the supplemental agreements and the side agreement. There was no justification for finding that either WCL or Barnett became subject at any stage to any obligation towards Ross River other than those set out in these agreements.
Barnett and WCL relied on observations such as those of Lord Walker in Cobbe v Yeoman's Row Management Ltd ( UKHL 55) to the effect that, as a matter of general principle, the court should be slow to introduce uncertainty into commercial transactions by the over-ready use of equitable concepts such as that of 'fiduciary obligations', and that the functions of equity in regulating commercial life must be kept within proper bounds. In particular, they argued that although there were cases in which a contract in the nature of a joint venture was found to impose fiduciary duties on one party, or on an individual standing behind one of the parties, there was nothing in the circumstances of the present case which could justify that course.
Ross River submitted that the judge was correct to find that both WCL and Barnett were subject to fiduciary duties, although it contended that the judge should have found the duties to be more extensive than he did. In particular, Ross River submitted that the judge should have held that the fiduciary duties prevented WCL from making any payments out of joint venture moneys other than proper payments of development expenses and payments that it had approved. Ross River contended that the costs of defending the litigation fell into the category of impermissible expenses.
Giving the leading judgment, Lord Lloyd found it to be clear from existing case law that although the analogy with a partnership may suggest that fiduciary duties are owed in the context of a joint venture, the phrase 'joint venture' is not a term of art in either a business or a legal context, and each relationship that is described as a joint venture must be examined on its own facts and terms to see whether it carries any obligations of a fiduciary nature.
Taking account of the judge's examination of the facts and the relationship between Ross River and WCL and Barnett, and in the latter case the finding that, based on his long-running involvement in the project, Ross River reposed a high degree of trust in him to run the joint venture for the benefit of all parties, the appeal judge accepted that the judge had been correct to find that WCL and Barnett owed fiduciary duties to Ross River:
"The control which WCL had over all aspects of the management of the joint venture project and over the disposal of the funds arising from it and of the assets comprised in it, and the control which Mr Barnett was able to exercise over WCL and what it did in all these respects, seem to me amply to justify the judge's conclusions… that both company and director were under… fiduciary duties."
Turning to the scope of the duties owed, the appeal judge considered that, having rightly identified that the circumstances of the joint venture agreement gave rise to fiduciary obligations on the part of WCL and Barnett to Ross River, the judge had not carried his decision to its logical conclusion in determining the consequences of these obligations.
In particular, the appeal judge considered that the judge had been wrong to approach the question of the propriety of WCL's expenditure by reference to whether it could reasonably have been foreseen at the time of making a payment that the payment could be met out of WCL's share of net profits. The appeal judge recalled that a fiduciary is under a duty to account and the only relevant question was whether any given payment was a proper payment by way of development expenses or whether it had been agreed to by Ross River. The appeal judge recalled the general principle that where a person is subject to a fiduciary obligation regarding its dealings with assets, it is up to that person to establish the justification for its dealings if there is any contest, rather than it being for the beneficiary to prove that the payment was unjustified.
As to legal costs, the appeal judge agreed with Ross River that the real dispute was between Ross River and Barnett, to which WCL was a necessary party but not one that had any separate interest of its own in resisting the claims. He found accordingly that it was a breach of fiduciary obligation for WCL to spend its own money on defending the proceedings, and for Barnett to procure that it should do so. The fiduciary obligation required Barnett to spend his own money if he wished to do so, and he should not have caused WCL to become jointly or severally liable for the defence costs.
Joint venture agreements are a common feature of commercial life and are often chosen by commercial parties as a vehicle for embarking on a common project because of their relative simplicity as compared with more formal and regulated structures, such as partnerships and companies. However, this case highlights that joint ventures can impose greater responsibilities on the parties than they bargained for in their joint venture agreement. Accordingly, parties to joint ventures should be aware of how the operation of the joint venture in practice can affect their legal rights and obligations beyond the contractual arrangements.
The case also provides useful guidance as to the circumstances in which causing a company to incur legal costs in defending a claim may amount to a breach of fiduciary duty.
For further information on this topic please contact Sarah Trimmings or Simon Hart at RPC by telephone (+44 20 3060 6000), fax (+44 20 3060 7000) or email (email@example.com or firstname.lastname@example.org).
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